What effects do Central Bank actions have on price of gold?

The World Gold Council reported that the world’s central banks made a sudden turnaround in August and sold more gold than they bought. This is the first month since February 2019 when the gold reserves of the world’s central banks fell. In recent times central banks stockpiled a record amount of gold, contributing to the rise in gold prices from $ 1,500 to $ 1,917. The price of gold has risen sharply due to the global economic crisis caused by the corona pandemic, escalating geopolitical tensions between the West and the East, and growing instability in the global financial system. The convergence of the three deep trends has created deep and favorable preconditions for strong gold price growth in world financial markets.

Investors in both Europe and North America are increasingly buying gold as the only so-called “Foolproof” financial assets, the value of which remains or increases even in situations where socio-economic crises may lower the values ​​of all other types of assets. Vulnerable assets include, in addition to financial instruments, a real estate whose prices are dictated by the functioning of credit institutions and which can quickly become illiquid or only be sold at extremely low prices.

The rapidly spreading understanding of the nature of gold as the only “reliable parachute” has led to a long-term upward trend in the demand for gold in an increasingly unstable world. The rise in the price of gold is, among other things, a ‘vote of no confidence’ in the financial system, and the price of iconic metal is taken as an unofficial barometer of the health of the money world. Consequently, it is in the interest of central banks to prevent an explosion in the price of gold.

At the same time, it is increasingly questionable to what extent the world’s central banks form a monolithic whole in their policies. On the one hand, all central banks should, in theory, be independent institutions with an interest only in ensuring the continuity of the global financial system. In reality, however, the relations of the political leaders of different countries of the world with their central banks are very different, and the geopolitical relations of the countries themselves vary or are antagonistic.

The central banks of the countries that continue to control the global monetary system (the central banks of the United States, Europe, the UK, Switzerland, and Japan, whose currencies account for more than 90% of the world’s reserve and trade currencies) are particularly interested in keeping gold prices low. In contrast, the motives of the world’s emerging central banks are less clear and may even run counter to the interests of Western central bankers.

The Russian central bank has long been the world’s largest buyer of monetary gold, China absorbs gold from world markets through the centrally monitored Shanghai gold market, and the world’s 13th largest Turkish central bank has become the world’s largest gold buyer. The last example is a textbook case of a situation where Turkey, as one of the countries with complex and uncertain geopolitical prospects, does not belong to the so-called “full member” of any economic bloc, secures its financial position with gold as the only highly liquid asset class that is independent of the grace of the global financial system. Regardless of whether Ankara quarrels with Washington, Beijing, or Moscow, the gold reserves in the national central bank’s stockpiles are always a guarantee for buying things from world markets that cannot be procured domestically (especially energy carriers).

According to the World Gold Council, central banks sold 12.3 tonnes more gold in August than they bought. Although broadly a negligible part of the world’s 35,000 tonnes of monetary gold reserves (monetary gold is gold held by central banks as an “ultimate” security asset that retains its value even if all other assets – mainly the US and European bonds – should collapse) it is a fact that for the first time in a year and a half, central banks sold more gold than they bought.

This is a development that may indicate a coordinated effort by central banks to keep the price of gold under control at a critical time when money pumped into the markets to combat the global economic crisis. Newly printed money that lands on the gold market may push up the price of gold and this is something that the central banks in the world’s reserve currencies want to prevent.

The gold reserves of the world’s central banks began to grow for the first time since the 2007-2008 global financial crisis, following the abandonment of the gold standard (1971). Among other things, the chart shows how central banks’ gold purchases were driven by emerging market central bank purchases (in yellow), while rich countries’ central banks’ gold reserves (in blue) stopped declining.

It is extremely uncertain whether the Western central banks, which have dominated in the gold market since the 19th century, will be able to do so in the future. Physical gold reserves have moved in parallel with the world economy’s wealth at an accelerating pace from West to East. It is unlikely that the West, with a declining share of the world’s physical gold, will be able to hold a dominant position in the global gold market.

The irreversible and explosive growth of the price of gold out of the control of central banks comes in a situation where the real economic crisis leads people to buy physical gold and “paper gold” no longer suffices. A taste of this situation emerged in the markets in the early stages of the pandemic, when the “world market price of gold”, based mainly on gold-based financial instruments was significantly lower than the price for physical gold due to very high demand for physical gold.

In any case, the cataclysmic crisis is also a scenario in which central banks would in fact refuse to sell their gold for purposes other than financing nationally important strategic imports.

For the average person, the more important issue is to secure part of their investment in physical gold thereby removing counterparty risk and protecting their assets in times of economic uncertainty.

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